Liquidation in general means taking any type of asset and turning it into cash. While you can certainly take cryptocurrencies and liquidate them into fiat currency, in crypto trading liquidation has a bit of a different meaning. This term is something that no trader wants to hear, and whenever your crypto trade is getting liquidated, it means that you have made a bad trade and went into losses. This is why understanding crypto liquidation is important and in this guide, we will explain what it means, and why it has such importance when trading.
What is crypto liquidation?
Cryptocurrencies are known to be highly volatile assets, meaning that even with a small amount of money you can make good profits if you catch the right side of this volatility. But what this also means is that, if you were to have more money to trade with, you will make even bigger profits. Therefore, most traders are always looking for different ways to achieve this objective. Margin trading with leverage is one of the most common ways to do so, and many traders are going down this route. When you are using leverage to trade with cryptocurrencies you are borrowing money from the exchange or a broker and using these additional funds to trade and make bigger profits. But when you open a trade using leverage, these exchanges need to protect the money that they are giving you, and for that, they introduce liquidations to leveraged trades.
Whenever you open a crypto trade using leverage, you will be given a liquidation value, which means that if the price of an asset reaches this value, your order will be liquidated and closed. This way exchanges protect their funds and avoid situations where traders opened a very bad position and lost all of the money. The value of liquidation will depend on the size of a trade you are opening, the crypto you are trading with, and the amount of leverage you are using.
Example of crypto liquidation
To better understand the meaning of crypto liquidation, let’s take a look at the example. Let’s say that we are opening a long position on BNB with $100 and 1:10 leverage, with the current BNB value being $310. What this means is that our trade will be worth $1000, instead of $100. Just before the opening of the trade, the exchange will provide us with the liquidation value. So in this example, let’s say this value is $300. What this means is that at the time of this trade opening, the price of BNB was $310 and if it falls and reaches $300, our trade will be automatically closed by the exchange. In this case, we managed to lose our $100 and there might even be instances where you will become indebted to the broker. This is a high-risk, high-reward trading style, but if you know what you are doing and use take-profit and stop-loss orders, you might never need to worry about liquidation.
FAQs on crypto liquidation
What is the crypto liquidation price?
Whenever you are trading with cryptocurrencies and use leverage to increase your trading power, you will be given a liquidation price. This tells you what price the asset needs to hit, in order for the exchange to think that this is a losing trade for them. If the price of an asset reaches this liquidation price, your position will be automatically closed by the exchange, making you lose your portion of the trade, and you might even end up owing the broker some money.
How to avoid crypto liquidation?
The best way to avoid crypto liquidation is to place take-profit and stop-loss orders. A stop-loss order is the more important one when it comes to liquidation and it should be placed above this liquidation price. So if the price goes against your trade, it will be closed before hitting the liquidation price, limiting the losses that might be incurred.